Cost Accounting Chapter Module-1 - Introduction to Cost Accounting Definition Cost: - Generally cost refers to all expenses incurred

in producing a product or rendering service. But, from the cost accounting point of view “Cost is a normal sacrifice of resources in the creation of product or services”. Costing: - Costing is defined as “the technique and process of ascertaining cost of a given thing”. According to CIMA it is defined as “the establishment of budgets, standard, costs and actual costs of operations, processes, activities or products and the analysis of variances, profitability or the social use of funds”. Cost Accounting: - Cost accounting is defined as “the process of accounting for cost from the point at which expense is incurred or committed to the establishment of its ultimate relationship with cost centers and cost units. The institute of Cost and Works Accountant ICWA defines “Cost accounting is the technique and process of ascertainment of cost. Cost accounting is the process of accounting for cost, which, begins with recording of expenses or the basis on which they are calculated and end with preparation of statistical data. Cost Accountancy: - Cost accountancy is used to describe the principles, conventions, techniques and systems which are employed in a business to plan and control the utilization of its resources. It is defined as “the application of costing and cost accounting principles, methods and techniques to the science, art and practice of cost control and the ascertainment of profitability. It includes the presentation of information derived there-from for the purpose of marginal decision making”. Cost Centre: - Cost centre is defined as “a place or location or machine or person or thing for which cost can be ascertained”. It is the segment of activity or area of responsibility for which costs are accumulated”. Cost Unit: - Cost unit is defined as “a unit of a product or service or combination of them in relation to which costs are ascertained or expressed”.

Objectives of Cost Accounting: - The main objectives or purposes of Cost accounting are as follows: 1. Ascertainment of Cost: - It enables the Management to ascertain the cost of product, job, contract, services etc. The cost is calculated, by aggregating expenses subject to certain concepts and conventions. 2. Analysis of Cost: - Total cost is broken down into several constituent parts according to some basis for eg. Material labour expenses. The detail information about these parts helps to know the significance of each in the total cost. 3. Cost control: - The object is to minimize the cost of manufacturing, comparison of actual cost with standards, reveals the discrepancies, variances. If the variances are adverse the management enters into investigation so as to adopt corrective action immediately. 4. Reduction of cost: - Reduction of cost refers to the permanent reduction in the cost of a product or service without impairing the quality and without affecting the purpose for which it is intended to be used. Due to an instance competition in the market, the management has little scope to vary the sales price. In such situation, it becomes necessary to look into the activities that reduce the cost component. 5. Fixation of selling price: - Cost accounting provides cost information on the basis of which selling prices of products or services may be fixed. In periods of depression cost accounting guides in deciding the extent to which the selling prices will be reduced to meet the special situation. 6. Guide to business policy: - Cost accounting aims at serving the needs of management in conducting the business with more efficiency. Cost data provides guidelines for various managerial decisions, like make or buy, selling below cost, utilization of idle plant capacity, introduction of a new product etc. Functions of Cost accounting In order to pursue the objectives cost accounting is expected to perform the following functions. 1. Cost book keeping: - It is a process of recording the relevant transactions to facilitate ascertainment of cost various accounts are maintained according to the principles of cost accounting. 2. Cost Analysis: - This is the function of establishing the relationship between the cost and the various determinants of cost. It involves the

determination whether a cost is direct cost or indirect cost, normal cost or abnormal cost etc. It serves costing objective. 3. Cost control: - This is the function of establishing relationship between what should happen and what has happened. Cost accounting facilitates preparation of standard cost and their comparison with actual cost and the analysis of variances to their causes and remedial measures. 4. Cost Comparison: - This is the function of comparing cost of alternative prospects, proposals, plans and actions. This comparison helps to take the right decision at crucial point of time. 5. Quotations: - Another important function of cost accounting is to measure or scientifically estimate the cost of a job or work order to quote the price. Getting the order depends on the appropriate quotations, lower price may fetch more order and higher price may fetch less order. 6. Cost Planning: - This is the function of planning involved in accounting for cost every cost segment or element should be properly planned and incurred accordingly. The overall planning of the organization should flow down to the level of incidence of cost in order to achieve the goal. 7. Cost Budgeting: - This is the function of facilitating to formulate the cost budgets; the budget sets the overall limit of expenses and the cost information guides to be within the set frame works. Advantages of Cost accounting: Following are the advantages of Cost Accounting: 1. Action against Unprofitable activities:It reveals unprofitable activities, inefficiencies such as wastage of materials and wastage of resources, inadequate utilization etc. The management is able to concentrate on profitable jobs and consider change or closure of the unprofitable jobs. 2. Facilitates Decision Making: It provides necessary data along with information to the management to take decision on any matter relating to the business. 3. Assists in fixing prices: - The various types of cost accounting are much helpful in fixing the cost and selling price of a product. 4. Improve Efficiency:-

Through the standard cost and budgetary control remedial action can be chosen in order to improve the efficiency and implement new principles. 5. Facilitates Cost Control: - It facilitates cost control possible by comparisons, product wise, department wise or firm wise. 6. Establishes Standard Cost: - It enables the managers to find out the cost of each job and to know what it should have cost. It indicates where the losses and wastes occur before the work is finished. 7. Inventory Control: - It enables the management to have an effective system and check on all materials and stores. 8. Prevents Fraud: - An effective costing system prevents frauds and manipulation and supplies cost data to the management. 9. Tool of Management Control: - It provides systematic and comparative reports to the management and in turn corrective measures can be applied immediately. 10. Measuring Rods: - It records the performance of different groups of workers, plant, and machinery etc for measuring their comparative efficiency. 11. Future prospects: - The cost accountant not only provides the present trend but future prospects also. 12. Budgeting: - As cost accounting reveals actual cost, estimated cost and standard cost of products, preparation of budget is easy. Disadvantages or limitations Cost accounting 1.) In cost accounting many judgments are biased and depend on the individual discretion. 2.) It is based on various assumptions leading to wrong conclusions in some cases. 3.) It is expensive and can be adopted only in big companies and not suitable for small concerns. 4.) It lacks uniformity in application. 5.) Post apportionment may be arbitrary. 6.) Different types of costs are required for different purposes. 7.) Determination of standards is subject to fluctuations leading to suspicion.

Financial Accounting versus Cost Accounting . FEATURES 1. Distinction Period/Amoun t 2. Coverage of transactions 3. Purpose FINANCIAL ACCOUNTING COST ACCOUNTING Transactions are recorded for a Transactions are identified definite period with cost units It covers transactions of the It covers only a part of the whole firm pertaining to transactions namely business- complete manufacturing, sales service etc - partial It prepares to show the final It aims to guide the results during a particular management for proper period to owners, outsiders etc planning, control and decision making The overall results of the It analyzes the profitability business can be revealed by p and un-profitability of each & l account but results of each department so that dept. cannot be known as such corrective measures can be corrective measures cannot be taken. taken. It does not tell us the It provides a system of good inefficiencies of material inventory control through a handling as the figures are prescribed procedure for available in aggregate purchases, storage issues etc. It deals with external It deals with internal transactions transactions It deals with actual facts and It deals partly with actual figures facts & figures & partly with estimate It makes no distinction It makes clear distinction between controllable and between controllable & uncontrollable or fixed and uncontrollable or fixed & variable costs variable cost. The cost can be reduced to the minimum. It is valued at cost price or It is valued at cost market price whichever less is. It does not reveal the relative It provides information of all efficiencies of workers, plant, operations and can compare machineries etc. with standard cost & deviations can be analyzed for corrective actions. They are kept as required by These accounts are Co’s Act, I.T. Act etc generally kept to meet the requirements of the Management

4. Efficiency

5.Material control

6. Transaction 7. Dealings 8.Classificatio n

9. Stock 10.Relative efficiency

11.Legal requirements

Methods of Costing Following are the important methods of costing: 1. Job Costing: It is defined by ICMA London as “that form of specific order, costing, which applies where work is undertaken to customer’s special requirements.” It means and applied to an industry, which produces a definite article against individual orders from customers. This is a system of costing where the items of cost are traced for specific jobs or orders. This type of costing is suitable to printing press, repair shops, furniture manufacture etc. 2. Contract Costing: The method of contract costing is applied where the job is big and of longer duration. For each individual contract separate accounts are kept and costs are ascertained. It applies to the concerns like construction of roads, bridges, buildings etc. 3. Batch Costing: A batch may represent a number of small orders partly in batches through the factory. The unit of cost is a batch or a group of identical products. The total cost of a batch is ascertained and the same is divided, by the number of units in the batch, so as to know the cost per unit. 4. Multiple Costing: It means combination of two or more of the above methods. This system of costing is adopted in manufacturing concerns where a variety of parts are produced separately and later assembled into a final product. It is also known as composite costing. One system of costing cannot be applied due to the fact each component differs from the other in respect of material in manufacturing process. 5. Process Costing: It applies to industries where production is carried on through different stages (process) before becoming a finished product. The output of each process becomes the input of the next process. Finished products are obtained at the end of each process. The method of ascertaining the cost of each such processes and the cost per unit at each process is known as process costing. 6. Single Output or Unit Costing: Under the method production is continuous and units are identical. By preparing a cost sheet the cost per unit is arrived at by dividing the total cost by the total number of units produced. 7. Operating Costing: This method is used by those industries, which render services instead of producing goods. This system is adopted

where expenses are incurred for provision of services. For eg. Transport companies, Electricity co’s, Railways etc. 8. Departmental Costing: It is a method of cost finding adopted to ascertain the cost of operating a department or a cost center separately. Techniques of costing 1. Historical Costing: It refers to the ascertainment of cost after they have been incurred. For example the expenditure on building, which is still in use? 2. Standard Costing: Standard cost is predetermined cost. The costs are determined in advance of production. Standard performance is said in terms of cost and actual costs are compared with the standards. 3. Uniform Costing: It is a system of costing which are adopted by the undertaking for all its products. This system enables inter-firm comparisons. 4. Marginal Costing: This system of costing differentiates between fixed cost and variable cost, Under this system the cost is ascertained for producing excess of a unit of a commodity. The cost that is saved by decreasing the production by one unit is called marginal cost. Cost Classification There are various ways of classifying cost, each classification serves a different purpose. Important classifications are given below. 1.) Functional Classification: On this basis costs are classified into the following groups. a.) Manufacturing Cost: Also named production cost or factory cost. This is the cost of the sequence of operation, which begins with supplying material, labour and services and ends with the completion of production. Examples of Manufacturing Cost are materials, wages, power, lighting etc. b.) Administration Cost: This is the general administration cost and includes all expenditure incurred in formulating the policy, directing the organization and controlling the operations of an undertaking which is not directly related to production and selling and distribution functions. Examples: Office rent, postage, legal expenses, audit fees, directors remuneration.

c.) Selling and Distribution Cost: Selling cost is the cost of seeking to create and stimulating demand and of securing orders. Examples:- Advertising, Salaries & Commission of Sales men, Showroom expenses etc. Distribution cost is the cost of sequence of operation, which begins with making the packed products available for dispatch, and ends with and ends with making the reconditioned returned empty package for reuse. Examples; Carriage outwards, Packing cost, Operating cost of delivery vans, Wearhousing etc. 2.) Classification according to variability or cost behaviour:a.) Fixed Cost: These costs remain fixed in total and do not increase or decrease when the volume of production increases or decreases. Ex; Rent, Managerial salaries etc. b.) Variable cost: These costs fluctuate in proportion to the volume of production. In other words when volume of output increases total variable cost also increase and vice versa. But the variable cost per unit remains fixed. Ex. Direct material cost, Direct wages, Power etc. c.) Semi- Variable Cost or Semi Fixed Cost: There are certain items of cost which are partly fixed and partly variable, these are termed as semi fixed or semi variable cost. Ex. In case of telephone expenses, there is a minimum rent and after a specified number of calls, charges are according o the number of additional calls made. Thus telephone costs are semi fixed. Other examples :- Depreciation, Indirect labour, repairs and maintenance etc. 3.) Classification of Cost into Direct and Indirect Direct Cost:- Direct costs are those which are incurred for and may be conveniently identified with a particular product, process or department. Cost of raw materials used and labour employed in the manufacture of a product are common examples of direct cost. Indirect Cost: Indirect costs are general cost and are incurred for the general benefit of a number of cost units, processes or departments. These costs cannot be conveniently identified with a particular cost unit or cost center. Depreciation of machinery, lighting, insurance, materials used in repairs etc. are common examples of indirect cost.

4.) Classification according to Controllability. a.) Controllable Costs: These are the costs, which may be directly regulated at a given level of management authority. Variable costs are generally controllable by departmental heads. Examples; Cost of raw materials may be controlled by purchasing in large quantities. b.) Uncontrollable Costs: These are those costs which cannot be influenced by the action of a specified member of an enterprise Fixed costs are generally uncontrollable. Examples; It is very difficult to control cost like factory, rent, managerial salary etc. Other classification 1.) Conversion Cost: The cost, which, is incurred to convert the raw material into finished product is called conversion cost. 2.) Opportunity Cost: This is the benefit foregone for having selected one alternative use against another for eg; the benefit lost for not having selected a project, which gives an income of Rs.10, 000/- as against a product selected which gives an income of Rs.12, 000/-. 3.) Imputed Cost: [Hypothetical Cost]: This type of cost is neither spent nor recorded in the books of account For ex. Interest on capital, Rent on freehold Premises etc; are notional costs. These types of costs are not actually incurred but are to be considered in making decision but in costing they are charged while ascertaining the cost of a product. 4.) Replacement Cost: It is a cost of replacing a material or product in current market. 5.) Sunk Cost: A cost which was incurred or sunk in the past and is not relevant to the particular decision, making, is a sunk cost. For ex.:- the expenditure on building which is abundant. 6.) Out of Pocket Cost : The cost which involves the cash outflow due to a particular management decision is called out of pocket cost for ex. Depreciation 7.) Shut down Cost: It refers to the cost which continue to occur even after the shutting down of the plant or temporary stoppage of

production activities such as salary of workmen, Rent, Depreciation etc. Cost Sheet: A cost sheet is a statement showing the detail of various elements of cost in the manufacture of a product. It is defined as a document, which provide for the assembly of the detailed cost of a cost center or cost unit. A cost sheet provides the split up of cost as prime cost, works cost, cost of production, cost of goods sold and sales. A cost sheet will reveal the cost per unit and well as total cost

Elements of Cost: The following chart shows the various elements of cost. Total Cost Material Direct Indirect Indirect Labour Direct Indirect Expenses Direct

Prime Cost

Overhead Overhead

Factory OH OH



Direct Material + D. Labour + D. Expenses Prime Cost + Factory OH Factory Cost + Administrative OH Cost of prodn + Selling & Distrn. Exp. Cost of Sales + Profit

= = = = =

Prime cost Factory Cost Cost of production Cost of sales Sales

In the books of ….. Cost sheet for the period of …..

Particulars Opening stock of Raw-material Add: Purchase of Raw-material Less: Closing stock of Raw-material Raw-materials consumed Add: Direct Wages Add: Direct Expenses Prime Cost Add: Factory Overhead Add: Opening stock of Work-in-progress Less: Closing stock of Work-in-progress Works Cost/Factory cost Add: Office and Administration overhead Cost of Production Add: Opening Stock of Finished goods Less: Closing stock of finished goods Cost of goods sold Add: Selling and distribution overhead Cost of Sales Profit/Loss Sales

Amoun t Xxxxx Xxxxx Xxxxx

Amoun t

Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx Xxxxxx

The cost is composed of three elements- Materials, labour and expenses. Each of these elements can be direct and indirect that is direct material and indirect material, direct labour and indirect labour, direct expenses and indirect expenses. Direct Material: Direct Materials are those materials, which can be conveniently identified with and allocated to cost units. Direct materials generally become a part of the finished product. Ex. Leather in shoe making, cloth in garments, timber in furniture. Direct Labour: Direct labour cost consists of wages paid to workers directly engaged in converting raw materials into finished products. These wages can be conveniently identified with a particular product, job or process. Wages paid to a machine operator is a case of direct wages. Direct Expenses: These expenses are also known as chargeable expenses, include all direct cost other than direct material and direct labour that are specially incurred for a particular product or process. Ex. Cost of special moulds & patterns, Royalties, higher charges of plant for a particular job etc are direct expenses. Prime Cost: The aggregate of direct material cost direct labour cost and direct expenses is termed as prime cost. Overheads: Overhead is the total of all indirect expenses. It is defined as “ the aggregate of indirect material, indirect labour, and indirect expenses. Overhead is also known as on cost, supplementary cost, burden etc. OH thus consists of three elements namely:- Indirect material, Indirect labour, and Indirect expenses. Indirect Material: They are those materials which cannot be identified with individual cost unit. These are generally minor in importance. Ex. Coal, Lubricating oil, Sand paper, soap etc. Indirect Labour: It is of general character and cannot be conveniently identified with a particular cost unit. Indirect labour is not directly engaged in production but only indirectly assists in production operations. Ex. Peon, Watchman Supervisor etc. Indirect Expenses: All indirect costs other than indirect materials and indirect labour cost are termed as indirect expenses. These cannot be directly identified with a particular job, process, or work order and are

common to cost units and cost centers. Ex. Rent & rates, Insurance, depreciation, Power, Cartage, Advertising etc. Overheads are classified into production overhead, administration OH, & Selling and Distribution OH. Production OH:- It includes all indirect costs which are connected with the manufacture of a product. It is also known as Manufacturing OH or Work OH. Ex. Factory rent, Coal, Depreciation of plant, power, grease, oil, lubricants etc. Office or Administrative OH: These are the OH’s incurred in the General management and administration of the enterprise. Ex. Office rent, Office lighting, Audit fees, Ofice printing & stationery. Selling and Distribution OH: Selling Oh’s are incurred in promoting sales and securing orders. Ex. Advertisement expenses, Salaries of salesmen, Showroom expenses. Distribution Overhead include all expenditure incurred from the time the product is complete and put in storage for despatch until it reaches customers. Ex. Upkeep and running cost of delivery vans, packing cost, wearhousing cost, carriage outwards etc. Installation of a Costing System Cost accounting is an independent system, many advantages are derived to the organization from the system. In the wake of computer invention the scope of the system is enlarged. Certain expenses are incurred to install this system. The advantages of this system would outweigh the expenses to be incurred, in the long run. Not only the big firms even the small firms can develop this system in a simple and small way. Proper care should be taken to see that the system is installed properly. Otherwise it may become a burden to the company. The extent of the requirement & complexity of the system depends on the objectives of the management. It must not only meet the internal needs but also the external needs such as legal requirements, Government and the industry. The installation of the costing system requires the following steps to be taken: 1. Preliminary investigations should be made relating to the technical aspects of business.

2. The organizational structure of the business should be studied to ascertain the scope of authority of each executive. 3. The methods of purchase, storage, and issue of materials should be examined and modified as per the requirements. 4. The existing methods of remunerating labour should be examined. 5. Forms and accounting records should be so designed so as to involve minimum clerical labour and expenditure. 6. The size and layout of the factory should be studied. 7. The system should be effective in cost control and cost reduction. 8. Costing system should be simple and easy to operate. 9. The installation and operation of the system should be economical. 10. The system should be improved gradually.

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